Food Prices, Financial Crisis and Droughts

Global food prices remain high and volatile, affecting the poorest countries the most. Global prices might not be at their 2008 record high, but they are still well above their levels a year ago. For millions who are already vulnerable, events like the droughts in the Horn of Africa add to their hardships while continued market turmoil increases uncertainty in the global economy.

And yet, for many it would look like the food crisis and the economic woes -- both past and present -- are two different events with little in common. In fact, experts will explain to you that a weak economic recovery would be a good thing for people struggling to put food on the table because lower demand would push food prices down. That's true, but the food price crisis and the financial troubles are not two completely separate things. The food price crisis that began in 2008 and the financial crisis of that year were intimately connected. Therefore, financial reform must include derivatives and other financial instruments related to developing countries and their farming sectors.

As Vera Songwe shows in the Economic Premise series note "Food, Financial Crisis, and Complex Derivatives: A Tale of High Stakes Innovation and Diversification" (PDF) "developing countries, particularly food-importing ones, were part of the early wave of the financial crisis via food price increases."

Here's the chain of events: The U.S. housing boom was accompanied by a dramatic increase in subprime mortgages and the creation of financial instruments to trade them. At the same time, Africa was experiencing unprecedented economic growth, fueled by a robust global economy driving commodity prices up. Once the U.S. economy overheated and interest rates came up, the housing market suffered a contraction that provoked a slowdown in U.S. growth, then the housing collapse and finally a financial crisis of major proportions in 2008 since America's leading banks faced substantial losses from the mortgage market. And all this at a time when agriculture production in Africa dropped, many countries increased their food imports, and world food stocks had fallen to their lowest levels since the 1980s.

"In September 2008," says Songwe, "Wall Street met No Street (rural Africa). Lehman Brothers collapsed, and the once separate food crisis in Africa and mortgage crisis in the U.S. transformed into a global financial crisis."

To make matters worse, the frequency of droughts is increasing in the Horn of Africa, affecting over 13.3 million people, often the poorest already. In Kenya, for instance, the seven counties most affected by the drought have an average poverty rate of 73 percent, so any policy response has to include an increase in social protection programs, as Gabriel Demombynes and Jane Kiringai explain in this week's Economic Premise, "The Drought and Food Crisis in the Horn of Africa: Impacts and Proposed Policy Responses for Kenya" (PDF).

But whether it is through more robust safety nets to protect vulnerable people from hunger and food price volatility or through increased investments in agriculture, efforts to address the food crisis also have to include financial reform. Food prices and volatility are intimately related to financial instruments, such as derivatives. So any comprehensive financial market regulation package must include commodity markets, financial products, and institutions linked to trade in agriculture commodities and, especially, the strong voice of developing countries struggling to feed their own.

As Vera Songwe says, "No country should be too small to fail."